CITY OF PHILADELPHIA CITY COUNCIL OFFICE OF THE PRESIDENT DARRELLL, CLARKE PRESDENT ROOM 404 CTY HAL Pica, PA TD? (2) 66.2079 Fo. 235) 5633162 June 25, 2015, COUNCILMAN STHOSTRIGT ‘The Honorable John Taylor 214 Ryan Office Building P.O. Box 202177 Harrisburg, PA 17120-2177 Dear Representative Taylor: Lam waiting with some sense of urgency to let yon know my position on a matter of great concer to me, and about which there may be some confusion, First, T enthusiastically support an amendment to the Pennsylvania Constitution that would authorize the General Assembly to permit Philadelphia to tax residential real property and commercial real property at different rates, Second, 1 do not support the drastic modification proposed by a group of business Jeaders (the “Job Growth Coalition”) that would cap at 15% the maximum by which the commercial rate could exceed the residential rates and require that other local taxes be reduced by the amount attributable to the difference in the two rates. This wholly unnecessary modification could jeopardize the fiscal well-being of our municipal government; if implemented, Council simply could not risk moving forward with dual rates, My support for dual real estate tax rates dates back to the fall of 2012, when Council was wrestling with AVI, the “Actual Value Initiative” -- Philadelphia's historic effort to reassess every property at its fair market value, Council’s analysis revealed that AVI would result in a massive shift in the telative share of real estate taxes from commercial properties to residential properties.To provide relief to homeowners, we came to Harrisburg with a package of proposals. And we were heard. Thanks to legislation subsequently enacted by the General Assembly, we mitigated the impact of AVI on long-term owner-oveupants whose home values had skyrocketed as a result of gentrification, and we gained additional authority to collect delinquent property taxes. Those measures alone, however, could not shift the allocation of taxes to the extent needed, so at the same time we also proposed an amendment to the Pennsylvania Constitution to permit dual real estate tax rates, knowing that such an amendment could take several years to enact, I continue to believe that such an amendment would be extraordinarily helpful. It ‘would allow us to allocate in a fair way the burden between homeowners and commercial property. Many local jurisdictions, including those in our neighboring states of New York. and Ohio, have the authority to set tax rates on different classes of properties. Having the same authority in Philadelphia would allow us to implement responsible tax measures lly designed (o strengthen and grow our City while enabling businesses to ‘compete successfully in the region and around the world, In response to our request, at least three bills have since been introduced that would accomplish our goal: House Bill No, 389 of the Session of 2013 proposed a Constitutional amendment providing that the General Assembly may authorize local taxing authorities in counties of the first class “to impose a rate of taxation on residential real property that is different from a rate of taxation on commercial real property.” House Bill No. 1693 of the Session of 2013 used the same language I have quoted but extended the amendment to cover all local taxing authorities, not just those in Philadelphia, Finally, House Bill No. 584 of the Session of 2015 is identical to HB 1693. The language in those bills that I have quoted is consistent with my position. 1 would also support authorization for more than two rates, as is sometimes the case in other jurisdictions. For example, the District of Columbia defines five separate classes of real estate, each taxed at a different rate (residential; business properties assessed at $3 million or less; business properties assessed at more than $3 million; vacant property; and blighted property), The Job Growth Coalition, on the other hand, while endorsing a higher commercial real estate tax rate than the residential rate for Philadelphia, only does so if at the same time, Council would have to reduce the rates of other local taxes -- mainly theWage Tax and Business Income and Receipts Tax — by an amount equal to the estimated yield from the differential in the two real estate tax rates. Again, I do not support that proposal. The Coalition has portrayed the proposal as “revenue neutral” to the City in the first years of the program, and then as “strongly revenue positive,” based on certain assumptions. I have come to believe that that portrayal is deeply flawed. Shortly after I met with representatives of the Coalition, I asked the past long-time head of Council's Technical Staff, Rick Auerbach, to evaluate the Coalition's proposal and underlying work product. I am enclosing a copy of Mr. Auerbach’s report (without supporting spreadsheets, which I can provide upon request). ‘The bottom line is this: ‘The Coalition’s math did not add up. Initial assumptions were erroneous. I quote: “As the following table shows, under this apples-to-apples analysis, the Coalition's proposal is in fact strongly revenue-negative to the City in years 3-10, and thereafter.” Correcting for the faulty initial assumptions, Mr. Auerbach found that, by the end of year 10, rather than a net revenue gain of $66 million, there would be a net revenue Joss of $91 million The report also noted deficiencies in the Coalition’s “elasticity” estimates — that is, how a change in a given tax rate would affect the base of that tax. For example, the Coalition evidently assumed that an increase in the real estate tax rate would have no impact on the real estate tax base, despite the generally held consensus that increases in real estate fax rates tend to depress real estate tax values. As a result, the Coalition’s the commercial real estate tax rate were projections overstate real estate tax collection inereased, I also asked Mr. Auerbach to evaluate the specific language of the Coalition’s proposal as then provided to me, The Coalition proposed amending the Pennsylvania Constitution to provide that the General Assembly may, by law: (vii) Permit a city of the first class to impose taxes on real estate used for business purposes at a tax rate that exceeds the tax rate applicable to other real estate provided that the rate applicable to other real estate shall not vary by more than 15% from the rate applicable 10 reat estate used for business purposes and provided that the General Assembly requires the cily of the first class to reduce the aggregate revenues from other taxes imposed on businesses and any wage &net profits tax by the amount of any real estate tax revenues atiributable 10 the variance. I understand the Coalition may since have modified its proposal: the limitations would remain, but instead of being in the Constitution itself, the General Assembly ‘would impose them, Nevertheless, the Coalition’s proposed language is deeply troubling. For example, the proposal seems to treat the real estate taxes in Philadelphia as a single tax, with a single rate (1.34% at the time the proposal was issued). As you know, however, this percentage in fact reflects the sum of two completely separate rates: one that supports the City’s municipal government; and one that supports the School District, Why does this matter? As Mr. Auerbach explains: “If any portion of the proceeds of an increase real estate tax on businesses goes to the School District, then the proposal, while revenue neutral to taxpayers as a whole, would be revenue positive for the School District and revenue negative for the City. That is because the required concomitant reduction of wage, net profits, and business taxes must all be taken on the “City” side, at least as long as Act 46 precludes reductions in School taxes.” (Emphasis added.) ‘There are more problems and ambiguities; here are selected examples: ‘+ Who would decide, and by what method, how much revenme an increase of the business real estate tax would generate, so that the City would know how much to reduce the other taxes? Who would decide, and by what method, the revenue reduction that would result from cutting the wage tax or the BIRT by @ given percentage? + The Coalition assumes that cuts to tax rates will increase the tax base and thereby increase tax revenues. Must these “base growth” effets be considered in deciding how much to reduce other taxes? If so, the City might be required to make even larger cuts to other tax rates, since a given tax rate reduction will, under the j Coalition’s assumptions, increase the relevant tax base and therefore have less of i a revenue-reducing effect. Could the City use a methodology that ignores the “pase growth” effects? © Could already-scheduled cuts in the BIRT or Wage Tax that are in the City’s Five-Year-Plan be considered as “offfetting” tax cuts to balance out a future increase in business real estate taxes, or would only “additional” BIRT cuts satisfy the requirement?© Would all rates have to be adjusted before the start of a fiscal year? If so, what happens if the City’s estimates prove to be wrong? Would the City be required to make additional cuts in future years to remedy any “shortfall” in prior year tax cutting measures, Ifa taxpayer challenged (ax rates as not in compliance, would a court defer to the City’s calculations, or would it decide itself what method to use? None of these questions is answered by the Coalition’s proposal. They do serve, however, to underscore the risks inherent in that proposal. In the end, even the language concerning the 15% cap is flawed: For example, the wording of the amendment, by stating that the residential rate may vary by no more than 15% from the business rate, would as a mathematical matter permit the business rate to be as much as 17.6% higher than the residential rate, (With a residential rate of 0.85 and a business rate of 1.00, the ratio of the business rate to the residential rate would be 1.00/.85 = 117.6%. In other words, the business rate would be 17.6% higher.) And, of course, the 15% figure is itself arbitrary. In closing, let me emphasize that I am a fiscal conservative. I believe in “squeezing every nickel” and raising taxes only as a last resort, when all other options have been exhausted, I have voted for and supported multiple reductions in local business and wage taxes with the goal of growing our local economy. I have only reluctantly voted to increase tax rates for the benefit of our financially distressed School District. I do support the gradual reduction of business and wage taxes, much as the Coalition does, and I greatly appreciate the Coalition’s willingness even to consider a higher tax rate on commercial properties. That said, the Coalition’s proposal to connect mandatory tax reductions to the separate idea of bifurcated real estate tax rates is poorly conceived, and I cannot endorse it, T would be happy to discuss this matter with you at your convenience. Sincerely, Paral 2 Cd DARRELL L. CLARKE DLCHdme Ene.: Memorandum: Some Quantitative Issues Raised by the “Job Growth Proposal” ce: Members of CouncilMEMORANDUM TO: Hal Fichandler, Senior Legislative Advisor FROM: Rick Auerbach, Consultant DATE: September 9, 2014 SUBJECT: Some Quantitative Issues Raised By the "Job Growth Proposal" You have asked me to review the "Job Growth Proposal" submitted by The Job Growth Coalition ("Coalition"). This memorandum sets forth some significant issues I believe are raised by the quantitative analysis provided by the Coalition in connection with its proposal to permit higher real estate tax rates on business properties, with offsetting cuts to other taxes.’ I will provide by separate memorandum an analysis of some issues raised by the Coalition's proposed language amending Article VIII, Section 2(b) of the Pennsylvania Constitution to implement its proposal. 1. Spreadsheet is not an “apples to apples" analysis The Coalition's spreadsheet attempts to estimate the revenue impact of an increase in commercial real estate tax rates coupled with decreases to the rates of the wage tax, net income tax, and net income portion of the business income and receipts taxes ("BIRT"). The spreadshect compares estimated revenues under those proposed tax rates to "baseline" revenues under the current 5 Year Plan. The current 5 Year Plan assumes certain reductions to the wage and net income tax rate (those reductions have not yet been enacted into law). In calculating "baseline" revenues, the Coalition's spreadsheet assumes that the wage and net income tax rate will continue to decline through 2025 at the same rate that wage and net income tax rates are planned to be cut during the last year of the 5 "1 previously sent you a draft of this memorandum in advance of your meeting with Eeonsult. Please note that the earlier draft included some analysis based on the first spreadsheet sent to you by the Coalition, rather than the revised spreadsheet the Coalition submitted, and some of the differences between this memorandum and the earlier draft are explained by those revisions (for example, the tables on p. 3 and p. 4 contain different numbers because of the spreadsheet revisions submitted by the Coalition). | | | | | |Year Plan (again, that planned cut in the fifth year of the Plan is subject to enactment of legislation by Council). The "baseline" revenues also assume that the rate of the net income portion of the BIRT will decline to 6% in 2023, and remain at 6% thereafter (those rate reductions have been enacted into law, per The Philadelphia Code, §19-2604(1)). The spreadsheet then calculates the revenue impact of the Coalition's proposed rates (the increase to commercial real estate taxes, coupled with greater cuts to wage, net income, and BIRT). However, in calculating those revenues, the spreadsheet does not use the same tax base as used in the 5 Year Plan. Instead, the spreadsheet assumes that the proposed tax rate changes will have the effect of growing jobs and businesses, which will mean an increase to the bases of the various taxes. The spreadsheet includes a tab that shows the various "elasticity" effects of each tax cut on all tax bases (in some cases, the spreadsheet assumes that a cut in one tax will increase the base of a different tax; e.g., it assumes that a wage tax cut will increase the real estate tax base). Under these assumptions, the spreadsheet concludes that the growth of the tax bases (and the increase in the commercial real estate tax rate) will more than offset the cut in wage, net income, and BIRT rates. As stated on p. 8 of its "Job Growth Proposal," the Coalition believes its proposal will be "strongly revenue positive to City in years 3-10." I do not believe the spreadsheet makes an apples-to-apples comparison of the Coalition's proposal to the baseline. As noted above, the baseline 5 Year Plan also assumes that cuts will be made to the rates of the wage tax, net income tax, and net income portion of the BIRT. Under the Coalition's assumptions, such already-assumed cuts will have the effect of increasing the tax base and therefore increasing revenues. Those increased revenues should have been included in the baseline against which the Coalition's proposal is compared. I have attached to the email transmitting this memorandum to you a spreadsheet ("EHA 9-9-2014 - Tax Shift Model Five Year Lag”) that I believe provides an apples-to-apples analysis.” It uses the same methodology as the Coalition's spreadsheet, but applies the Coalition's “elasticity” model to the ? ‘That spreadsheet follows the same analysis as the spreadsheet | emailed to you with the earlier draft of this memorandum, but it has been revised to include the other taxes the Coalition included in its revised spreadsheet (parking, amusement, school income, and liquor taxes).“baseline” rates in order to adjust "baseline" revenues on an “apples to apples" basis (those adjusted revenues are shown in the tabs with the “cha” label). The tab labeled "cha - Total - apples" is a summary that compares the Coalition's calculated net revenue change to what | believe is an appropriately adjusted net revenue change, As the following table shows, under this apples-to-apples analysis, the Coalition's proposal is in fact strongly revenue-negative to the City in years 3-10, and thereafter: Coalition's calculated net | Adjusted net revenue change - Flasticity applied revenue change (in millions) to baseline rates (in millions) a 2015 7 - 2016 1 0 2017 0 Q) 2018 ©. ® 2019 5 (16) 2020 20 (20) 2021 33 GI) 2022 46 (48) 2023 59 (66) 2024 66 om 2025 R (19) 2026 106 fap) 2027 134 (13) 2028 156 a2) 2029 169 a3) 2030 174 ain 2031 179 21) 2032 185 (24) 2033 190 (128) 2034 196 (133) 2035 201 (37) A second “apples-to-apples" approach would be to consider the "elasticity" effects only with respect to the amount by which the Coalition's proposed tax cuts exceed the tax cuts already in the 5 Year Plan (and as projected thereafter). This would mean that in computing baseline revenues, the tax bases would grow as projected in the 5 Year Plan, but would not grow further as a result of any "elasticity" effects of the 5 Year Plan tax cuts, on the theory, perhaps, that those effects are already built in to the tax base growth projections in the 5 Year Plan (although I believe that in fact, the projected increases of the tax base shown in the5 Year Plan are independent of tax rates). Under this approach, baseline revenues would be the same as calculated by the Coalition, but the projected "elasticity" effects would be smaller (since the percentage decreases from the 5 Year Plan rates will be less than the percentage decreases the Coalition computed from the 2015 base rates). I have followed this alternative approach in a second spreadsheet ("Alternative 9-9-2014 apples-to-apples method") attached to the email transmitting this memorandum to you.’ That spreadsheet is identical to the one sent to you by the Coalition, with one exception. Under the "RE Wage BIRT" tab, the chart entitled "Alternative Percentage Change in Rates" is adjusted to show the percentage changes not from 2015 rates, but from the rates in the 5 Year Pian, as projected (i.e., what the Coalition calls the "baseline" rates). As shown in the "Total" tab, under this method the Coalition's proposal is more or less revenue neutral during the first two years, but increasingly revenue-negative thereafter: Coalition's calculated net revenue | Adiusted net revenue change - Elasticity change (in millions) applied only to marginal rate cuts below baseline rates (in millions) 2015 - : 2016 1 0 2017 0 Q) 2018 0 @) 2019. 5 a (as) 2020 20 7) 2021 33 (24) 2022 46 (38) 2023 59 en 2024 66 (70) 2025 2 @l) 2026 106 (82) 2027 134 (73) 2028 156 cm) 2029 169 70) 2030 174 (72) > Again, that spreadsheet follows the same analysis as the similar spreadsheet I emailed to you with the earlier draft of this memorandum, but has been revised in line with the Coalition's revised spreadsheet to include parking, amusement, school income, and liquor taxes.2031 179 (7) 2032 185 7) 2033 190 (79) 2034 196 (82) 2035 201 (85) 2. Elasticity error The Coalition's spreadsheet includes a tab showing how a change in any given tax rate will impact the base of each tax (the "elasticity" estimates). Some of the impacts are "cross-effects"; for example, a cut in the wage tax, the Coalition believes, will have the effect not just of increasing the wage tax base, but also the real estate tax base. The Coalition also assumes that "Net profits tax revenue will increase by 29 percent of the reduction in BIRT net income revenue due to lower tax rates (reflecting the tax credit available to firms that pay both the NPT and BIRT)" (see Coalition's "Assumptions of Tax Shift Revenue Model 8.18.14 (revised), p. 3). However, if cuts to the tax credit result in a significant increase in net profit tax revenue, that is in effect an increase in the rate of the net profit tax (certainly, the economic effect on a taxpayer is the same whether rates are increased or credits are reduced). That effective increase to the net profit tax rate should (following the Coalition's analysis) result in a reduction to the net profit tax base. Accordingly, the elasticity estimates for the net profit tax should include an entry under the column entitled "BIRT NI rate." However, the Coalition's spreadsheet has a zero in that column, both for the resident and non-resident net profit tax base. The effect of this correction would be to lower the estimate of net income tax revenue under the Coalition's proposal, but the exact amount would of course depend on the elasticity estimate. 3 Elasticity estimates for real estate tax base The Coalition assumes that increases (or decreases) in the real estate tax rate will have no impact on the real estate tax base (elasticity = 0). However, I believe there is a consensus that increases in real estate taxes depress real estate values, and decreases in real estate taxes increase real estate values. If that is correct, why is the elasticity of the real estate tax base to real estate tax rates zero? If the correct | | | | |estimate of elasticity is some number less than zero, then the Coalition's projections have overstated real estate tax collections under the scenario of an increase in the commercial real estate tax rate. Also, please note that the Coalition does assume that the real estate tax base will be positively affected by cuts to the wage tax rate (elasticity = -.26). Whether or not that is reasonable is beyond my expertise. However, it should be noted that a significant portion of the positive revenue effects shown in the Coalition's spreadsheet are due to the claim that the real estate tax base will increase with decreases to the wage tax. In fact, without that claimed increase to the real estate tax base, Coalition's proposal would be net revenue-negative through 2025 (without any other changes being made to the Coalition's own calculations), and at least 69% of the net revenue gains the Coalition estimates after 2025 are due to the real estate tax base increase. The last tab (labeled "Effect of re. elasticity") of the "EHA 9-9-2014 Tax Shift Model Five Year Lag" spreadsheet supports those conclusions.’ 4, Other issues a. The Coalition states that the "the proposed increase in commercial real estate taxes occurs up-front in years one and two in the model, whereas the reduction in wage and BIRT taxes occurs gradually over 10 years" ("Assumptions of Tax Shift Revenue Model 8.18.14 (revised), p. 1.). However, it is important to remember that under the proposed Constitutional language provided by the Coalition, any increase in commercial real estate taxes resulting from the higher rate for business properties must be fully offset by reductions to wage and BIRT taxes, including in years one and two. Therefore, the additional tax cuts proposed by the Coalition after year two are greater than the minimum tax cuts that would be needed to offset the higher commercial real estate tax rate, which does not increase after year 2.° That is not to say whether or not those additional tax cuts are good policy or not. However, policy makers should be “ When I sent you the prior draft of this memorandum, | included this analysis in a separate spreadsheet, rather than including it as part of the larger spreadsheet. > The prior draft of this memorandum (and accompanying spreadsheet) included a discussion as to whether the Coalition's proposed rates met the Coalition's proposed Constitutional tax cutting requirement. 1 deleted that material because I was not sure whether and how to handle the "elasticity" effects in determining the revenue impact of proposed rate cuts.aware that the Coalition's tax rate proposals should be considered in two categories: (1) those rate reductions necessary to offset the proposed increase to commercial real estate taxes, as required by the Coalition's proposed Constitutional language; and (2) those additional rate cuts the Coalition believes would be beneficial to the City's economic growth. b. 1 had a few comments on the text of the "Job Growth Proposal" submitted by the Coalition: i. Page 4 (assuming the cover page is considered p. 1) shows the "outflow" of workers from districts (by the way, please note that the “old” districts are shown, i.¢., the districts from which members were elected in 2011, but not the new districts from which members will be elected in 2015). It says that 37% of the workforce commutes outside the City, but that seems to be low, given the generally higher totals shown for each district (the discrepancy might be because there are fewer workers in those districts showing the higher percentages). In any event, this is not really relevant to any of the Coalition's quantitative analysis. ii, Page 6 claims that the S$ Year Plan assumes job contraction because the growth of wage tax receipts is assumed to be less than the growth of wages. I'm not sure if that is correct. The 5 Year Plan also assumes cuts to the ‘wage tax rate, and that would mean that if employment is assumed to be stable, wage tax receipts will grow by less than the rate of wage growth. Again, this is not really relevant to any of the Coalition's quantitative analysis. iii, Page 8 states that the Coalition's plan is to permit the commercial real estate tax rate to be 15% more than the residential rate, That statement is in conflict with the Coalition's proposed Constitutional language on p.9, which states the residential rate can vary by no more than 15% from the commercial rate (which would mean that commercial rate could be about 17.6% higher than residential; e.g., 1.0 commercial, .85 residential). The rates proposed by the Coalition are 1.34 residential and 1.54 commercial. Under those rates, the commercial rate varies from the residential rate by a little less than 15%, while the residential rate varies from the commercial rate by about 13%. Please note that assuming the residential rate is fixed at 1.34, then, under the Coalition's proposed Constitutional language, the maximum commercial rate could be set as high as 1,34/.85, or a little more than 1.57.